Do Pinnacle West Capital Corporation’s (NYSE:PNW) Returns On Capital Employed Make The Cut?
Today we'll evaluate Pinnacle West Capital Corporation (NYSE:PNW) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Pinnacle West Capital:
0.045 = US$757m ÷ (US$18b - US$1.6b) (Based on the trailing twelve months to September 2019.)
So, Pinnacle West Capital has an ROCE of 4.5%.
See our latest analysis for Pinnacle West Capital
Does Pinnacle West Capital Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Pinnacle West Capital's ROCE is fairly close to the Electric Utilities industry average of 4.6%. Putting aside Pinnacle West Capital's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
You can see in the image below how Pinnacle West Capital's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Pinnacle West Capital's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Pinnacle West Capital has total assets of US$18b and current liabilities of US$1.6b. As a result, its current liabilities are equal to approximately 8.6% of its total assets. With barely any current liabilities, there is minimal impact on Pinnacle West Capital's admittedly low ROCE.
Our Take On Pinnacle West Capital's ROCE
Nonetheless, there may be better places to invest your capital. You might be able to find a better investment than Pinnacle West Capital. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
